10 May 2012

Bundesbank/Dombret: How to manage financial crisis from a systemic viewpoint

In his speech, Mr Dombret said that at the end of last year, "we saw clear signs of a systemic financial crisis. Recently, tensions in the market have renewed due to doubts of the solidity of the fiscal positions of some countries."

In some countries there is nevertheless some deleveraging pressure; but this is, or was, due to the refinancing needs of their banks and is not caused by the recapitalisation plan itself. On the contrary, if a loss in confidence is a major reason for the refinancing problems, restoring confidence through publicly assisted recapitalisation might be a key tool to mitigate excess deleveraging. Moreover, deleveraging consists of both structural and cyclical components. It cannot easily be separated into “good” deleveraging which enforces the necessary adjustment of business models and “bad” deleveraging which implies a reduction of healthy business.

Given its institutional structure and the nature of its instruments, the comparative advantage of the ESRB lies not with crisis management. It lies less than ever with constructing “swords” for cutting the knot, but in crisis prevention and mitigation, that is in disentangling the knot.

At an early stage, the ESRB can identify fundamental and local factors with the potential to prepare the ground for a systemic event. It can also recommend counteractive regulatory measures. This gives it the chance to address potentially systemic risks at an early point in the cycle. Once successfully implemented it can unburden itself, for example, of its monetary or fiscal policy tasks. This allows policymakers in those areas to concentrate on their own targets, leaving it to those responsible for macro-prudential oversight to safeguard financial stability.

For example, if it is the case that low interest rates lead to excessive leverage or to excessive risk-taking or to house price bubbles in some countries in a monetary union there is nothing that monetary policy can do about this. By contrast, once we have macro-prudential instruments at our disposal we can use a leverage ratio or a loan to value ratio, just to mention two options. The ESRB has recognised the importance of having sufficient flexibility.

Establishing a macro-prudential policy framework in a monetary union reminds me of a complicated balancing act. That is, first, to find the right balance between a sophisticated system which is fine-tuned to any marginal change in systemic risk and an approach based on easy-to-implement rules. The second challenge is to find enough flexibility when implementing instruments without endangering the level playing field. So far the discussion is not completed and requires also some practical experience.

Full speech

© Deutsche Bundesbank